Appunti di Business Law, Appunti di Diritto Commerciale

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 The laws and regulations applicable to the economic activities Business law Business law, also called commercial law or mercantile law, is the body of rules, whether by convention, agreement, or national or international legislation, which governs the dealings between persons in commercial matters. Business law governs business and commerce and it is a branch of the civil law. Business law falls into two distinctive areas: 1. the regulation of commercial entities by the laws of company, partnership, agency, and bankruptcy. Deals with persons (individuals or other legal entities) who do business. 2. the regulation of commercial transactions by the laws of contract and related fields. Areas with the actions of such persons. Legal entities A legal entity is defined as a lawful or legally standing association, corporation, partnership, proprietorship, trust, or individual. Has legal capacity to 1. enter into agreements or contracts, 2. assume obligations, 3. incur and pay debts, 4. sue and be sued in its own right, and 5. to be accountable for illegal activities. There are various forms of legal business entities ranging from the sole trader, who alone bears the risk and responsibility of running a business, taking the profits, but as such not forming any association in law and thus not regulated by special rules of law, to the registered company with limited liability and to multinational corporations. In partnerships two or more owners (members or associate) form collectively an association in which they all participate in management and sharing profits, bearing the liability for the firm’s debts and being sued jointly and severally in relation to the firm’s contracts or tortious acts.
 An agent is a person who is employed to bring his principal into contractual relations with third parties. Various forms of agency, regulated by law, exist: 1. universal, where an agent is appointed to handle all the affairs of his principal 2. general, where an agent has authority to represent his principal in all business of a certain kind 3. special, where an agent is appointed for a particular purpose and given only limited powers. In Italy a special regulation is given for certain types of agents.
 Bankruptcy When a person or company is insolvent (i.e., unable to pay debts as and when they fall due), either he or his creditors may petition the court to take over the administration of his estate and its distribution among creditors. Three principles emerge: 1. to secure fair and equal distribution of available property among the creditors 2. to free the debtor from his debts 3. to enquire into the reasons for his insolvency. 1 Law Contract A contract, usually in the form of a commercial bargain involving some form of exchange of goods or services for a price, is a legally binding agreement made by two or more persons, enforceable by the courts. As such they may be written or oral, and to be binding the following must exist: 1. an offer and unqualified acceptance thereof 2. intention to create legal relations 3. valuable consideration 4. and genuine consent (i.e., an absence of fraud). Business law in Italy The Italian Business Law is focused on the definition of enterprise and entrepreneur. In fact, when an individual or a legal entity satisfies such definition, a set of legal rules are applicable. The Italian civil code (ICC) defines the entrepreneur as “the person who engages professionally in an economic activity organised for the purpose of production or exchange of goods or services” (Section 2082, ICC). As a consequence, the requirements to qualify as an entrepreneur are as follows: 1. Economic activity
 The entrepreneur engages in an activity aimed at the production of additional wealth. This includes the production and/or the exchange of goods and/or services. The definition of “economic activity” can also include the enjoyment of assets
 Ex. where an entrepreneur owns a building and turns it into a hotel or a residence. In that case, the entrepreneur enjoys the building as he/she earns rent for each room, but at the same time he/she provides clients with a wide range of services (such as the use of common facilities, concierge and reception services etc.). 
 However, the mere enjoyment of an asset will not be considered to constitute an “economic activity” under Italian law. That is, the landlord-owner of a building is not an entrepreneur if he/ she simply rents the building to one or more tenants. 2. Organisation
 To qualify as an entrepreneur, a businessman must carry out an “organised” economic activity, which means that the entrepreneur must employ productive factors, namely capital and/or labour, and must combine these factors into a proper organisation designed to carry out the economic activity. 3. Economic method
 The legal definition of “enterprise” also requires that the economic activity is carried out in such a way as to allow costs to be covered by revenues and to ensure economic self- sufficiency. Therefore, one will not qualify as an entrepreneur if one produces goods or services that are given away or disposed of below cost. A businessman or a business organisation may incur losses and – notwithstanding this – still qualify as an entrepreneur/ enterprise under Italian law: what the law requires is that the institutional purpose of the enterprise be at least to cover costs with income, while it is of course possible for losses to be incurred on an occasional or even continuous basis. 4. Professionalism
 Section 2082 of the ICC provides that an entrepreneur is somebody who engages professionally in an organised economic activity. This means that, to qualify as an entrepreneur, one needs to perform the economic activity in a regular and not occasional way. Seasonal economic activities such as the management of a hotel in a vacation resort 2 Law An important function of corporate law is to reduce the ongoing costs of organizing business through the corporate form by i) facilitating coordination between participants in corporate enterprise, and by ii) reducing the scope for value- reducing forms of opportunism among different constituencies. Most of corporate law can be understood as responding to three principal sources of opportunism that are endemic to such organization: 1. conflicts between managers and shareholders, 2. conflicts between controlling and non- controlling shareholders, and 3. conflicts between shareholders and the corporation’s other contractual counterparties, including particularly creditors and employees. All three of these generic conflicts may usefully be characterized as what economists call “agency problems.” Legal personality A firm is as a “nexus for contracts” in the sense that a firm serves, fundamentally, as the common counterparty in numerous contracts with suppliers, employees, and customers, coordinating the actions of these multiple persons through exercise of its contractual rights. The core element of the firm as a nexus for contracts is what civil lawyers refer to as “separate patrimony.” This involves the demarcation of a pool of assets that are distinct from other assets owned, singly or jointly, by the firm’s owners (the shareholders), and of which the firm itself, acting through its designated managers, is viewed in law as being the owner. The core function of this separate patrimony has been termed “entity shielding” , i.e. shielding the assets of the entity—the corporation—from the creditors of the entity’s owners. Entity shielding involves two relatively distinct rules of law: • priority rule that grants to creditors of the firm, as security for the firm’s debts, a claim on the firm’s assets that is prior to the claims of the personal creditors of the firm’s owners. • liquidation protection that provides that the individual owners of the corporation (the shareholders) cannot withdraw their share of firm assets at will, nor can the personal creditors of an individual owner foreclose on the owner’s share of firm assets For a firm to serve effectively as a contracting party, two other types of rules are also needed: First, there must be rules specifying to third parties the individuals who have authority to buy and sell assets in the name of the firm, and to enter into contracts that are bonded by those assets. The particular rules of authority governing the corporation is “delegated management”. Second, there must be rules specifying the procedures by which both the firm and its counterparties can bring lawsuits on the contracts entered into in the name of the firm. Starting from the premise that the company is itself a person, in the eyes of the law, it is straightforward to deduce that it should be i) capable of entering into contracts and owning its own property; ii) capable of delegating authority to agents; and iii) capable of suing and being sued in its own name. Limited liability The limited liability doctrine holds that shareholders of a corporation are not personally liable for corporate obligations and thus put at risk only the amount of money that they invested in buying their shares. So limited liability shields the firm’s owners—the shareholders—from creditors’ claims. The “owner shielding” provided by limited liability is the converse of the “entity shielding”, a component of legal personality. Entity shielding protects the assets of the firm from the creditors of the firm’s owners, while limited liability protects the assets of the firm’s owners from the claims of the firm’s creditors. 5 Law Transferable shares Fully transferable shares distinguishes the corporation from the partnership and various other standard-form legal entities. Transferability permits the firm to conduct business uninterruptedly as the identity of its owners changes. A transfer of stock has no effect on the corporation, except that there is now a new voter of those shares. This in turn enhances the liquidity of shareholders’ interests and makes it easier for shareholders to construct and maintain diversified investment portfolios. Fully transferable shares do not necessarily mean freely tradable shares. Even if shares are transferable, they may not be tradable without restriction in public markets, but rather just transferable among limited groups of individuals or with the approval of the current shareholders or of the corporation. We refer to corporations with freely tradable shares as “open” or “public” corporations, and we will correspondingly use the terms “closed” or “private” corporations to refer to corporations that have restrictions on the tradability of their shares. The shares of open corporations may be listed for trading on a stock exchange, in which case we will refer to the firm as a “listed” or “publicly traded” corporation, in contrast to an “unlisted” corporation. A company’s shares may be held by a small number of individuals whose interpersonal relationships are important to the management of the firm, in which case we refer to it as “closely held,” as opposed to “widely held.” Separation of ownership and control Corporations differ from most other forms of business organizations in that ownership of the firm is formally separated from its control. Although shareholders nominally “own” the corporation, they have virtually no decisionmaking powers—just the right to elect the firm’s directors and to vote on a limited number of corporate actions. Management of the firm is vested by statute in the hands of the board of directors, who in turn delegate the day-to-day running of the firm to its officers, who in turn delegate some responsibilities to the company’s employees. The conflicts of interest created by his separation of ownership and control drive much of corporate law, especially the fiduciary obligations of officers and directors. Bergle and Means’ They identified three types of public corporations, classified according to the nature of share ownership within the firm: • Majority control: a corporation having a dominant shareholder (or group of shareholders acting together) who owns more than 50% of the outstanding voting shares. • Minority control: a corporation having a dominant shareholder (or group of shareholders acting together) who owns less than 50% of the outstanding voting shares, but is nevertheless able to exercise effective voting control. • Managerial control: a corporation in which no one shareholder (or group of shareholders acting together) owns sufficient stock to give him working control of the firm. Managerial controlled corporations exhibit complete separation of ownership and control: While separation of ownership and control facilitated the growth of large industrial corporations, Berle and Means recognized that that separation created the potential for shareholder and managerial interests to diverge. Delegated management with a board structure 6 Law More specifically, business corporations are distinguished by a governance structure in which all but the most fundamental decisions are generally delegated to a board of directors that has four basic features: 1. The board is, at least as a formal matter, separate from the operational managers of the corporation. 2. The board of a corporation is elected—at least in substantial part—by the firm’s shareholders. 3. Though largely or entirely chosen by the firm’s shareholders, the board is formally distinct from them. 4. The board ordinarily has multiple members. Investor ownership There are two key elements in the ownership of a firm: i) the right to control the firm (which generally involves voting in the election of directors and voting to approve major decisions), and ii) the right to receive the firm’s net earnings. In an investor-owned firm, both the right to participate in control and the right to receive the firm’s residual earnings, or profits, are typically proportional to the amount of capital contributed to the firm (default rule). Sometimes core corporate law itself deviates from the assumption of investor ownership to permit persons other than investors of capital—for example, creditors or employees—to participate in either control or profit- sharing, or both. Special and partial corporate forms All jurisdictions with well-developed market economies have a least one core statute that establishes a basic corporate form with the five characteristics described above, and that is designed particularly to permit the formation of public corporations. There are also special and partial corporate forms. In articular, major jurisdictions commonly have at least one distinct statutory form specialized for the formation of closed corporations or limited liability companies. These forms—including the Brazilian Ltda, the French SARL, the German GmbH, the Italian Srl, the Japanese godo kaisha, the American limited liability company, and the UK private company—typically exhibit most of the canonical features of the corporate form. • Their shares or quotes, though generally transferable at least in principle, are presumed—and in some cases required as in Italy—not to trade freely in a public market. • Sometimes these forms permit elimination of the board in favor of direct management by shareholders. • Commonly permit special allocations of control, earnings rights, and rights to employment among shareholders that go beyond those permitted in the core public corporation statute. What is corporate law (from The Anatomy of Corporate Law) There are 5 basic characteristics of the business corporation. In market economies almost all large-scale business firms adopt a legal form that possesses all five of those. They are: 1. legal personality - “nexus of contracts”; most of the important relationships within a firm are essentially contractual in character. Corporate law permits a firm to serve this coordinating role by operating as a single contracting party that is distinct from the various individuals who own or manage the firm. “Separate patrimony” - the demarcation of a pool of assets that are distinct from other assets owned, singly or jointly, by the firm’s owners and of which the firm itself, acting through its designated managers, is viewed in law as being the owner
 “Entry shielding” - priority rule that grants creditors of the first, as security from the firm’s debts, a claim on the firm’s assets that is prior to the claims of the personal creditors of the firm’s owners. A firm’s assets are, as default rule of law, automatically made available for the enforcement of contractual liabilities entered into in the name of the firm. Might be weak 7 Law Shares may not be issued at a price lower than their nominal value or, in the absence of a nominal value, their accountable par. Contribution other than cash The 2nd Directive requires the subscribed capital to consist only of cash or assets capable of economic assessment. To secure the latter’s value, any contribution other than in cash must be subject to an independent expert’s report. An undertaking to perform work or supply services may not be part of these assets. The independent expert’s report on any consideration other than cash must contain i) a description of each of the assets comprising the consideration and ii) of the methods of valuation. It states iii) whether the values corresponds at least to the number and nominal value (or the accountable par) and, if existing, to the premium on the shares. The requirements for consideration other than cash apply not only on the formation of the company but also for the issue of shares in any period subsequent to the incorporation. Special rules: 1. where transferable securities are contributed as consideration, on the condition that they are valuated at the weighted average price at which they have been traded on one or more regulated markets. 2. when assets are contributed not more than three months after they have already been subject to a fair value opinion by a recognized independent expert 3. when their value is derived from the statutory accounts of the previous financial year. Post formation acquisitions Within at least a two-year period after incorporation, the acquisition of assets may be subject to the same provisions described before and must be submitted for approval of the general meeting. This applies where the assets belong to a person or company that has signed the instrument of incorporation or to a Shareholder or other person. This provision does not apply to acquisitions done on the ordinary course of the company’s business on in other special cases. Maintenance and reduction of the capital Distributions to shareholders are not permitted if the net assets as set out in the company’s annual accounts would become lower than the amount of the subscribed capital plus those reserves that may not be distributed under statutory law or the articles (undistributable reserves). The amount of distribution may not exceed the amount of the profits and sums drawn from reserves available for this purpose, less any losses brought forward and sums placed in undistributable reserves. Any reduction in the subscribed capital must be subject to a decision of the general meeting. Creditors may oppose and ask for security. In any case the subscribed capital may not be reduced for an amount less than the minimum capital. In cases of a serious loss of the subscribed capital, a general meeting must be convened to consider whether the company should be wound up or whether any other measure should be taken. The amount of the loss deemed to be serious may not be set by the laws of the Member States at a figure higher than half of the subscribed capital. In Italy it is 1/3 of the subscribed capital. The acquisition of the company’s own shares If the law of a Member State permits a company to acquire its own shares, these acquisition shall be subject to conditions laid down the 2nd Directive: 10 Law 1. There has to be an authorization by the general meeting; 2. The acquisition may not have the effect of reducing the net assets below the subscribed capital plus the undistributable reserves 3. Only fully paid-up shares may be included in the transaction. Further conditions may be added. In particular that the nominal value of all acquired shares is not allowed to exceed the 10% of the subscribed capital or the higher limit set by national laws. Special options are provided for some specific cases. For example when the shares are acquired for distribution to the company’s employees. The voting rights attached to the shares held by the company itself are to be suspended. If the shares are included among the net assets shown in the balance sheet, an undistributable reserve of the same amount shall be included among the liabilities. Financial assistance by the company for the acquisition of its shares by a third party subject to conditions (fair market value, shareholders approval, limit of the net assets). Alteration of the capital According to the 2nd Directive, the general meeting has to decide on any increase in capital unless this power is transferred (limited to a maximum amount and for a maximum period of five years) to another body Where there are several classes of shares, the decisions of the general meeting shall be subject to a separate vote for each of the class of shareholder, whose rights are affected by the transaction. The new shares must be offered on a pre-emptive basis to shareholders in proportion to the capital represented by their shares. This pre-emptive right may be restricted or withdrawn by the general meeting (or by another body). Such decision must be taken by no less than two-thirds of the share capital represented. Financing the corporation in the EU: Share capital One of the traditional means utilized to finance companies is share capital (also called equity). It represents a capital fund, contributed to by the members and available to creditors in fulfilment of the company’s liabilities to them. Usually the company’s capital is divided into shares, which can differ with regard to their form and transferability. The share capital includes: i) the nominal value of allotted shares; ii) the amount of any premium paid and iii) capital reserves, which companies are required to retain. As seen above, 2nd Directive requires Member States to enact rules pertaining to both raising and maintaining share capital of public companies. This Directive also addresses the alteration (increase and reduction) of share capital, including purchase and redemption by a company of its own shares, and the financial assistance provided by a company for the acquisition of its own shares by a third party. Companies may also issue shares without a par-value i.e. a nominal value. Financing the corporation in the EU: Loan capital The loan capital of a company may include i) loans from a specific lender, such as a bank or a finance company; and ii) bonds issued by the company, which are debt securities that are supposed to be repaid (normally at a fixed date) and attract interest payments rather than dividends. A bond is a written and signed promise to pay a certain sum of money on a certain date or upon the fulfilment of specified conditions. In the case of liquidation, bondholders are paid off before shareholders, and their interest payment are given priority and paid before shareholders’ dividends. 11 Law Convertibles are usually bonds or convertible preferred shares that contain an option to convert the security into another form of security, normally common stock, at a fixed price and time. The conversion of these securities can lead to an increase in the share capital and turn the creditor into a co-owner of the company (therefore causing shareholder dilution). So the issuance of such securities is governed by the share capital increase rules laid down by the 2nd Directive. Mezzanine capital is regarded as a form of debt, typically subordinated to a senior bank loan. This means that mezzanine creditors can only be paid off after all senior creditors have been paid in full, which increases the risk of non-repayment of the mezzanine loan. Financing the corporation in the USA Corporate Capital Structure In the US, a corporation’s capital structure consists of the permanent and long-term contingent claims on the corporation’s assets and future earnings issued pursuant to formal contractual instruments called securities. There are two basic types of securities: debt and equity. The funds needed to finance the corporation will come also from bank loans or retained earnings, not through selling debt or equity securities. Equity securities Equity securities are issued in the form of shares, which represent “the units into which the proprietary interests in a corporation are divided.” A corporation as being owned by the holders of its equity securities. Holders of debt securities are not in any sense owners of the corporation; rather, they are creditors of the corporation. It follows that: 1. Corporate officers and directors owe fiduciary duties to the equity security holders. 2. In contrast, the relationship between the corporation and its debt security holders is essentially contractual. Directors and officers normally owe no fiduciary duties to debt security holders. Different risk exposure: 1. Equity securities represent the “residual claim,” which means their holders are entitled to whatever funds are left after all other claims on the corporation’s assets and earnings have been satisfied. 2. In contrast, debt securities represent a fixed claim on the corporation’s assets and earnings superior to that of the equity. Because debt securityholders are entitled to be paid before the equity securityholders, they are less likely to be hurt by sub-par corporate performance. Duration: 1. Although equity securities often change hands, the securities themselves represent permanent claims on the corporation. 2. In contrast, debt securities usually are limited in duration. At some contractually specified date, the debt security will mature and the corporation will pay off the principal. Types of equity securities 1. Common stock carries two basic rights, voting and economic. The number of votes which can be cast by any one shareholder are determined by the number of shares owned, usually on a one-vote per share basis. As to economic rights, holders of common stock possess the residual claim on the corporation’s assets. 2. Preferred Stock is given certain rights superior to those of common stock. Preferred stock may have a preference over common stock with respect to dividends and/or liquidation. Preferred stock with a dividend preference will receive dividends before any are paid to the common stock. Dividends differ significantly from interest payable on a bond: 12 Law The delegated organs must report to the board of directors at least every six months on the trends and perspectives of the company's business and on the transactions of major relevance for the company. On the other hand, the nonexecutive directors should: Evaluate the adequacy of the organisational, administrative and accounting structure of the company on the basis of the information received from executive directors; examine the strategic, industrial and financial plans of the company, if any; and evaluate the general trend of the company's business on the basis of the information received from the delegated organs. The chairman must ensure that pre-meeting information is supplied in a timely and accurate manner. Strong information powers are attributed to the board of auditors. Appointment and removal of board of directors The general meeting appoints the directors. Only individuals can be appointed as directors (to the exclusion of legal entities). 
 The term of appointment cannot be for more than three fiscal years and expires on the date of the AGM convened for the approval of the financial statements relative to the last year of appointment. Directors can be re-elected. 
 Board members of listed companies are elected on the basis of slate voting, which should assure that also minority shareholders are represented on the board of directors 
 Directors can be removed by the general meeting at any time, but removal without cause entitles the removed director to recover damages from the company. 
 A director can resign from the office by sending a written notice to the board and to the chairman of the board of auditors. The resignation is effective immediately, provided that a majority of directors remain in office; otherwise, the resignation takes effect only from the time when the majority of the board has been reconstituted through the appointment of new directors and acceptance by the same. 
 Moreover, in the case of vacancy of a seat, it is possible for the board to co-opt a new member by resolution approved also by the board of auditors; if a vacancy of the majority of seats occurs, the remaining directors shall call a general meeting. 
 In cases of serious mismanagement, the tribunal can replace the board by appointing a judicial administrator. Directors’ liability Directors can be held personally liable towards the company, the creditors and one or more shareholders or third parties. Article 2392, concerning the ‘liability to the company’, provides that directors are jointly and severally liable for damages deriving from non-compliance with their duties, except for functions vested solely on either the executive committee or one or more directors. This does not mean that non-executive directors (delegated directors) are relieved from liability when individual directors are tasked with specific functions (such as delegated directors) or an executive committee is appointed. Rather, they shall be liable when at fault in performing their monitoring duties. Directors are jointly and severally liable if, knowing of a conduct prejudicial to the company, they omit doing what is in their powers to prevent the same and either remove or reduce its harmful consequences. The company can sue directors for damages only following to a resolution of either the shareholders' meeting or the board of auditors. 15 Law Lesson 7 Managing the corporation Corporate governance models • The one-tier or Anglo-Saxon model (UK, USA, former British colonies): the shareholders’ meeting appoints a board of director. • The two-tier or German model: the shareholders’ meeting appoints a board of supervisors and the board of supervisors, in turn, appoints (and might revoke) a managing board. • The traditional Latin model: the shareholders appoint both the board of directors and a separate body entrusted with controlling functions: the “commissaires aux comptes” en France, the “collegio sindacale” in Italy, the “auditors” in Spain, the “Kausayaku-Kai” in Japan and the “jian- shi-hui” in China. The workers co-determination • Historical origins in Germany after WWII • Main function: it lowers the corporation’s contracting costs by reducing asymmetries between firms and the labour unions with whom they negotiate. This function is relevant where firms are confronted with labor unions and where wages are in fact determined by collective bargaining agreements. • Co-determination offers some protection against bullying employees and more in general to respect employees’ rights, which is a problem more present in countries were employees cannot be terminated without cause. The choices between various models Several countries have made available different governance models to their corporations: a corporation can, in its bylaws, opt for one of two or sometimes even three models. This gives the shareholders to decide which model better satisfy their needs. Possible reasons of the choice: • Costs • Business combinations • Managing generation transitions • Subsidiary of foreign companies • To make hostile takeovers more difficult • Inertia or path-dependency. Corporate boards in Europe 1. Appointment
 — In the one-tier board system that prevails in the UK and many other countries, the shareholders appoint and remove the directors by voting in the general assembly.
 — In the two-tier system—as in Germany—shareholders appoint the members of the supervisory board, which in turn appoints the members of the management board. 
 In most countries, the general assembly votes upon proposals of candidates by the board, though minority shareholders and sometimes even single shareholders may submit additional candidates: principal–agent conflict. 
 
 Mitigation techniques (for listed companies): 
 ▪nomination committee 
 ▪Active shareholders 
 ▪Minority representation (as in Italy) 
 
 
 
 
 16 Law The rules on duration of office vary considerably (1/3/5 years). A fixed maximum time limit for service on the board is rare. Exceptions to the general rule of appointment of the directors by the shareholders: 
 —mandatory labour co-determination: the board is split between the shareholder and the labour representatives, usually by two-thirds to one-third or, exceptionally as in Germany, even by half to half. 
 —Other constituencies, as set by articles of association (very rare for listed companies): normally at least more than half of the directors must be chosen by the shareholders 
 
 Methods to give single shareholders or a minority more influence: 
 — nomination rights for particular shareholders in the articles of association
 — cumulative voting and slate voting. 2. Removal
 The competence to remove directors before the end of their term lies in principal with the same body responsible for the appointment: 
 — the shareholder in the general assembly 
 — the supervisory board for management board member 
 — labour in codetermined boards 
 — the shareholder with a special nomination right. 
 
 How different rules protect board members: 
 — removal without cause and without compensation 
 — removal without cause, but with preservation of compensation rights under the service contract
 — the supervisory board may not remove the management board members before the end of the office unless there is cause (D) 3. Division of powers between Board and Shareholders 
 In general and as a majority rule, the company is managed and controlled not by the shareholders but by the board and, under its supervision, the officers; or in a two-tier system, by the management and the supervisory boards. 
 Only certain key powers are reserved to the general assembly: 
 — Catch-all clauses 
 — Catalogue listings
 — Court decisions
 Articles of association
 Instructions to the board – Advisory votes 4. Liability rules Lesson 8 Managing the corporation: Director’s duties Directors’ duties in the EU Substantive law governing directors duties covers a wide range of material and procedural aspects: — where and how directors’ duties are addressed in the law – regulatory approach — who owes the duties and to whom; — how the interest of the company is defined; — what represents the material content of the directors’ duties – duty of care, duty of loyalty; — the nature of liability, covering in particular the extent to which an individual director is liable for decisions taken by the board; — the type of liability flowing from breaches of the duties, and limitations to the liability 17 Law Corporate opportunities Corporate opportunities can be defined as business opportunities in which the corporation has an interest. The effectiveness of the regulation of corporate opportunities thus depends on two factors: — First, is the exploitation of corporate opportunities by the directors for their own account restricted and, if yes, under which conditions (disclosure, disinterested approval, etc.) are the directors free to pursue a business opportunity that belongs to the corporation? — Second, how is it determined when a business opportunity ‘belongs’ to the corporation? With respect to both dimensions, the law may adopt a narrow approach (i.e., the regulation is applicable to a narrowly defined set of cases) or a broad approach (applicable to a wide range of directors’ activities). Nature of liability The board of directors is a collegiate body, but liability is personal; it does not attach to the board as a corporate organ (which does not have legal personality), but to the individual director. So what happens in case of different behaviour of the directors regarding a board decision? As a general rule, where the concurrent acts of several parties cause damage, the parties are jointly and severally liable to the injured person: the claimant (the company, shareholders, or third parties where personal right are infringed) can claim compensation for the whole amount of the loss from any one of the directors. Principles present in all EU jurisdictions: — First, directors who vote in favour of resolutions in violation of directors’ duties are jointly and severally liable if they have acted with fault. As far as liability for negligent misconduct is concerned, this means that the assessment has to proceed on an individual level. — Second, directors who vote against resolutions in violation of directors’ duties are in principle not liable. However, several jurisdictions provide that voting against the resolution alone is not sufficient to exonerate the director. — Third, the director may even face liability if he or she was absent while the board resolved to take the challenged decision. In fact the directors have an obligation to participate in the decision- making by the board and that repeated absence may amount to negligence with regard to the director’s monitoring duty. Lesson 9 Managing the corporation: The business judgement rule in the US The duty of care and the business judgement rule The duty of care requires corporate directors to exercise “that amount of care which ordinarily careful and prudent men would use in similar circumstances. As a consequence, one might assume the duty of care is violated when directors act negligently. At this point, however, one encounters the business judgment rule which insulates directors from liability for negligence. Two basic ways of reconciling the duty of care and the business judgment rule compete in the case law: — One treats the rule as a standard of review. Some courts argue that the business judgment rule shields directors from liability so long as they act in good faith. Others argue that the rule simply raises the liability bar from mere negligence to, say, gross negligence or recklessness. — The other conception one sees in the case law treats the rule as an abstention doctrine that creates a presumption against judicial review of duty of care claims. The court will abstain from reviewing the substantive merits of the directors’ conduct unless the plaintiff can rebut the business judgment rule by showing that one or more of its preconditions are lacking 20 Law Why business judgement rule ? The business judgment rule’s traditional justification is that courts are not business experts. One explanation for the business judgment rule focuses on decision-maker incentives. — Judges necessarily have less information about the needs of a particular firm than do that firm’s directors. A fortiori, judges will make poorer decisions than the firm’s board. — Rational shareholders might prefer the risk of managerial error to that of judicial error. But this only extends to decisions motivated by a desire to maximise shareholder wealth. — Where the directors’ decision was motivated by considerations other than shareholder wealth, as where the directors engaged in self-dealing or sought to defraud the shareholders, however, the question is no longer one of honest error but of intentional misconduct. Despite the limitations of judicial review, rational shareholders would prefer judicial intervention with respect to board decisions so tainted. A second justification for the business judgment rule is that it encourages directors to take risks. According to the ALI PRINCIPLES, for example, the rule protects “directors and officers from the risks inherent in hindsight reviews of their unsuccessful decisions” and avoids “the risk of stifling innovation and venturesome business activity.” Explanation valid but not sufficient. Why hindsight review of business decisions is inconsistent with shareholder interests? — limited liability substantially insulates shareholders from the downside risks of corporate activity — portfolio theory teaches that shareholders can eliminate firm- specific risk by holding a diversified portfolio. — On the contrary, managers will be averse to risks shareholders are perfectly happy to tolerate. — The diversion of interests as between shareholders and managers will be compounded if managers face the risk of legal liability, on top of economic loss, in the event a risky decision turns out badly. — Moreover, knowing with the benefit of hindsight that a business decision turned out badly likewise could bias judges or juries towards finding a breach of the duty of care. — Rational shareholders therefore should prefer a regime that encourages managerial risk-taking by, inter alia, pre-committing to a policy of not litigating the reasonableness of managerial business decisions. Based on the considerations above, the business judgment rule should be treated as an abstention doctrine rather than a standard of review. As a consequence, judicial review is more likely to be the exception rather than the rule. Starting from an abstention perspective, the court will begin with a presumption against review. It will then review the facts to determine not the quality of the decision, but rather whether the decision-making process was tainted by self-dealing and the like. The requisite questions to be asked are objective and straightforward: Did the board commit fraud? Did the board commit an illegal act? Did the board self-deal? Did the board make an informed decision (i.e., exercise process due care)? The merits of the board’s decision are irrelevant, as well they should be. The business judgment rule thus builds a barrier by which courts pre-commit to resisting the temptation to review the substance of the board’s decision. 21 Law The law of business judgement The duty of care requires directors to exercise the same care that “ordinarily careful and prudent men would use in similar circumstances. The business judgment rule, however, provides that courts will abstain from reviewing board decisions unless those decisions are tainted by fraud, illegality, or self-dealing. It is “a presumption” that the directors or officers of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. So, courts assume they should not review director decisions absent fraud, illegality, or self- dealing. Preconditions: • An Exercise of Judgment • Disinterested and Independent Decision-makers • Absence of Fraud or Illegality • Absence of Waste (when the consideration received is so clearly inadequate that the transaction effectively amounts to a gift of corporate assets serving no corporate purpose) • Rationality (not present where the decision under attack is “so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith”) • An Informed Decision (a.k.a. Process Due Care), i.e. as a rational and good faith decision- making process:
 — Smith v. Van Gorkom (Delaware Supreme Court, 1985): directors must inform themselves of all material information reasonably available to them 
 — Ali principles: directors must be informed to the extent that they reasonably believe to be appropriate under the circumstances. The contextual business judgement Not a rule but a standard: the question is not whether the directors violated some bright-line precept, but whether their conduct satisfied some standard for judicial abstention. Three distinct versions of the business judgment rule can be identified:
 — One is the traditional business judgment rule under which courts essentially decline to review decisions made by the board. — A second, arguably more intrusive, variant of the business judgment rule is applied in cases which involve the sale of the business. — The third variant, which might be called a conditional business judgment rule, is applied to takeover defences. Operational decisions typically (and appropriately) receive much less probing review than do the structural ones covered by the latter two variants of the rule. Lesson 10 Corporate law and securities market Why companies need stock markets Large businesses require important financial resources and to collect them it may become necessary to involve outside investors. For such investors two incentives are needed: i) limited liability, which is provided by the company legislations and ii) stock markets, which allow investor to realise their investment. Otherwise higher return will be required to invest. Stock markets provide a primary market through which a company can offer its shares to the public and so raise capital and a secondary market where investors can trade in those shares. Once listed, the company may use the stock market to raise further capital. 22